The Value Proposition (#141)

In this podcast episode, we cover the value proposition that a business presents to its investors. Key points made are:

• The value proposition is the theme of the business; it describes the intrinsic value of the entity.

• When you have multiple divisions, it can make sense to split the business apart and assign different value propositions to each one, to maximize the total value of the business.

• Get rid of low-value operations that interfere with the value proposition.

• You need to consider the value proposition when making tactical decisions, since each one contributes to how well the business is perceived as matching its value proposition.

• You can fiddle with the value proposition to associate it with a higher-value market niche.

• Paying attention to the value proposition can greatly increase the stock price of the company.

• A muddled value proposition can reduce the market value of a business, so getting it right makes a great deal of sense.

Related Courses

Investor Relations Guidebook

Public Company Accounting and Finance

The Cost Accountant Position (#140)

In this podcast episode, we talk about how to reorient the cost accountant position to make it more effective. Key points made are noted below.

Problems with the Position

I’m bringing up this job position because there’re several interpretations of what a cost accountant is supposed to do. And if you set up the job in a certain way, it’s not very cost-effective. The basic problem is the title itself. A controller decides that he needs a cost accountant, because he wants to know what things cost. This seems reasonable, since you supposedly make decisions based on what things cost, and doing so saves the company money.

The reality is a little different. For example, what if a company has a standard set of products, and management wants to know the total actual gross margin on each product, every month. So the cost accountant spends hours and hours compiling the cost of materials and labor and allocates overhead really well – and what do you get?

Well, even if we sidestep the issue of which costs really should be included in this type of analysis, what we’re going to find is that the margins hardly ever change. Costs are built into products in the design stage. Once they’re designed, there isn’t much variation from month to month. So, management figures this out after a few months, and stops looking at the reports – and those are the reports that no one told the cost accountant to stop producing. This might sound familiar to you.

I reviewed a company that had this exact situation, and had them lay off the entire cost accounting staff, because the information they were producing had no actionable value. And that’s the key point. You can have a cost accountant churn out all kinds of costing reports. But if you don’t do anything with the information, why have the cost accountant?

Complying with the Accounting Standards

Instead of focusing on cost reporting, you can break down the job into two pieces. The first part is required costing work that you need in order to issue financial statements. This means valuing ending inventory, which, in turn, means reviewing inventory accuracy, and overseeing the month-end cutoff, and allocating overhead, and so on. Now, this is all required, but it’s not value added. You’re just complying with the accounting standards.

And that means there’s a tradeoff here. Inventory valuation needs to be right, but it doesn’t mean that you encourage the cost accounting staff to investigate immaterial items. This is essentially a cost benefit balancing act, where you have cost accountants spend just enough time overseeing inventory valuation to ensure that the result is pretty good. Not perfect, but good enough for the auditors.

Value-Added Cost Accounting

With any luck, that means there should still be enough time available for some value-added work. I’ve already talked about how compiling product gross margins is not really value added, since no one uses the information. Instead, we have to reorient the cost accounting work into areas that actually make a difference. And there are a couple of them.

First up is target costing. You might remember this from Episode 57. Target costing is about designing products to meet a certain price point and profit, which means that you have to pay close attention to the designed cost. This is perfect for a cost accountant, because you’re helping to ensure that products are going to be profitable.

Second is constraint analysis. I covered constraint analysis in Episodes 43 through 47. It involves focusing on whatever the company bottleneck is that keeps a company from generating more profit. The traditional location for the bottleneck is the production department, though I usually see it in the sales department. Anyways, the cost accountant should continually review the performance of the bottleneck, and keep suggesting ways to improve performance right there, or to route work around it.

Any improvement in a constraint has an immediate impact on profits, so there’s a clear cost-benefit involved in having the cost accounting staff work in this area.

And my third recommended task is what I’m calling the investigation of unusual stuff. You can quote me on that. It means looking into any expense item that’s out of the ordinary. I’m not referring to variance analysis, which is tracking volume and efficiency variances from standard amounts. There’re so many ways to fudge the baselines used for variance analysis that I find that whole system of analysis to be essentially useless.

Instead, cost accountants should look for any expense that jumps above the historical trend line, and investigate it. This is pretty easy. You just run a report that lists each expense monthly basis for the past year, and investigate anything that bumps above the average. And this isn’t just finding out what the amount is and reporting it to management.

A really effective cost accountant drills down to find out why the expense occurred, and if it can be avoided, and makes a complete recommendation to management. You can even take this a step further and have the cost accountant be responsible for making whatever change is needed, which really converts the position into sort of an internal consultant or troubleshooter. The reason for this extra level of investigation and pushing for changes is that department managers frequently ignore variance reports.

So instead, the cost accounting staff presents them with the problem and the solution, and even offers to fix it. And that provides value.

Summary of the Position

So let’s summarize what a cost accountant should really be doing. If a company has ending inventory, then there’s always going to be a block of time required to value it – but just enough time to avoid any material mistakes.

All remaining time should be spent on projects that are going to enhance company profits. This means getting involved in the design of products, and constraint analysis, and making sure that unusual expenditures don’t happen again.

What the cost accountant should not be doing is compiling the same old cost reports, month after month, about how much the same old products cost.

Related Courses

Constraint Management

Cost Accounting Fundamentals

Financial Analysis

A Lean System for Fixed Assets (#139)

In this podcast episode, we discuss several best practices that are designed to reduce the accounting work related to fixed assets. Key points made are noted below.

The Problems with Fixed Assets

As I’ve been pointing out in the last couple of episodes, we’re assuming that “lean” means doing accounting with minimal resources. That’s pretty tough to do with fixed assets. Consider all of the accounting you have to do. There’s setting up a depreciation calculation, and the related journal entry, and doing a fixed asset roll forward to make sure that you didn’t screw up anywhere. And when you eventually dispose of the asset, there’s a disposal transaction to figure out, maybe with some gains or losses. And on top of that, you have to review the larger items for impairment. And there may be asset retirement obligations to keep track of. And, if you’re using international financial reporting standards, you may be revaluing the assets up or down. Two problems with all of this. First, it’s a lot of work. And second, if you want to be in compliance with the accounting standards, then you have to do all of it. From the perspective of introducing lean concepts, it initially looks like you’re completely screwed.

Lean Suggestions for Fixed Assets

But that’s not quite true. Let’s look at this from the perspective of how much each fixed asset costs. If you make a list of all your fixed assets and sort them by cost, the result is going to look like a pyramid. There’ll be a couple of really expensive assets at the top of the pyramid, and there’ll be a whole pile of low-cost ones across the base of the pyramid.

Since we can’t eliminate any of the accounting work associated with fixed assets, the next best thing to do is to get rid of the assets – in particular, the ones along the base of the pyramid.

There’re two ways to do this, and you should go after both of them. First, the threshold at which you call something a fixed asset instead of an expense is called the capitalization limit, or the cap limit. You want to reset the cap limit so that it excludes all of the lowest-cost fixed assets. For example, if you’ve been capitalizing laptop computers, stop that right now. Those are office supplies. Seriously. Just taking this one step will wipe out a huge chunk of your fixed assets. Yes, it will increase the amount you charge to expense in the short term, but it’s just not that much money.

The second lean improvement involves something called base unit aggregation. A base unit is a company’s definition of what constitutes a fixed asset. So if you’re constructing a building, a lot of invoices go into a single fixed asset item. That’s fine. The problem is when you aggregate a lot of low cost items into a fixed asset that’s barely above the cap limit in total. For example, you could have a fixed asset called a group of desks. Each of those desks would normally have been charged to expense. Because you aggregated them, the group is a fixed asset. That’s bad.

What you should do is disaggregate those desks, which means you record them individually. Then they fall below the cap limit, and you won’t have to record them as fixed assets. And that gives you a more lean accounting department.

And for that matter, how do you track a group of desks? They’re going to be in different rooms, and they’re going to keep getting moved around over time. You won’t even know if they’re gone. It’s just not logical to use aggregation.

Those are my two main improvement areas for lean fixed assets. But there are some other possibilities, and they all involve doing the simplest possible accounting. If you keep it simple, there’s less room for error, and that means it’s easier to reconcile the accounting records.

First, only use one depreciation method, and make that method the straight-line method. It’s the simplest one, it’s really hard to screw up, so why not? Most of the accelerated depreciation methods are just the reverse – it’s kind of unusual not to make a mistake.

Second, don’t bother adding salvage value to the depreciation calculation unless you’re dead certain there’s going to be a salvage value, and it’s going to be material. Otherwise, you’re just going to complicate the depreciation calculations, that means it’s easier to screw up.

Next, avoid interest capitalization like the plague. It’s complicated to calculate the amount.

So if you’re only constructing an asset for a short period of time, do everything you can – legally – to avoid capitalizing any interest expense.

And finally, there’s asset classes, like computer equipment and furniture & fixtures. A lot of companies assign a standard useful life and depreciation method to all of the assets within each asset class. The trouble is that if you every move something from one class to another, you may have to change the useful life and the depreciation method. Which gets complicated.

My recommendation is pretty obvious. Just keep it simple. You should use the absolute minimum number of asset classes that you can get away with, since that way, you don’t need to worry about putting something in the wrong asset class, and then having to readjust the depreciation or the useful life to match the asset class that you should have put it into.

So what have lean concepts done for us? You should have far fewer fixed assets to track, and you should have standardized the accounting for those fixed assets that are left.

There’ll still be a few really expensive assets that require the full range of fixed asset accounting, with impairment analysis and asset retirement obligations, but those are going to be the exception. Most of the other assets won’t even be there anymore.

Related Courses

Fixed Asset Accounting

How to Audit Fixed Assets

Lean Accounting Guidebook

A Lean System for Accounts Payable (#138)

In this podcast episode, we discuss how to reduce the work load associated with the payables function. Key points made are noted below.

As I mentioned on the last episode, we’re assuming that “lean” means doing accounting with minimal resources. And again, we’re going to look at the whole process and locate those spots in the system where we can reduce the need for resources.

Recap of the Payables Process

Let’s start with a quick recap of the payables process. If you do a full three-way match, it means starting off with a comparison of the authorizing purchase order to the supplier’s invoice and a receiving report. If the invoiced price or quantity doesn’t look right, then you have to investigate further. And if there wasn’t a purchase order, then you send the invoice out for an approval. And after that, you pay the invoice.

Problems with Payables

This is a pretty crappy process, for two reasons. First, the three-way match means that the payables staff has to sort through a lot of paperwork. And there’re going to be missing documents and there’ll be variances that cause all kinds of extra work. And second, some managers are awful at returning invoices that they’re supposed to approve. So from a lean perspective, there’s too much time being wasted in accounts payable. If we want to operate payables with minimal resources, we can do so by spending less time on it. How do we do that?

Improvements to Payables

The first step is to completely avoid the three-way match. The easiest way is to have a rule that if an invoice is below a certain amount of money, no match is required. When you set that minimum threshold, do some analysis first to figure out what threshold will eliminate a bunch of invoices that aren’t too expensive.

The second step is to figure out which suppliers are completely reliable in submitting accurate invoices. If their invoices are absolutely always correct, then you don’t need to do a three-way match. Instead, audit their invoices every now and then, just to make sure that they’re still accurate.

And that is the key point. If you can train suppliers to issue perfect invoices all the time, there’s no need for a three-way match.

The impact from a lean perspective is massive, so this is absolutely worth pursuing. If you want to go down this path, it means setting up a system where the payables staff tracks which invoices went through the three-way matching process, and did not have any errors.

If you see several perfect invoices in a row, set a flag in the vendor master file to show that those suppliers are certified to avoid the three-way match. Also, if a supplier is having invoicing problems, then route this information back to the purchasing department, and request that a different supplier be used. And on top of that, start communicating directly with the supplier’s billing department to point out errors. Over time, you might be able to train them into a higher accuracy level.

If you go through these steps, there should only be two types of invoices still going through the three-way match. The first is invoices from new suppliers, who haven’t been evaluated yet. And the second type is invoices that suppliers keep screwing up – and those are the ones you want to be reviewing.

And by the way, the one thing you don’t want to do is spend a bunch of money to buy software that automates the matching process. It’s expensive, and you have to load every line item on every invoice into the system, and that requires a lot of clerical time. Instead, the lean approach is to use the system as little as possible.

Now let’s switch over to that other problem with invoice approvals, where it can be hard to get invoices back from the approvers. As you might expect, the lean view of things is to completely avoid approvals. But there are times when someone really should take a look at an invoice. So, what can we do?

One option is to automatically approve all invoices below a certain threshold amount. And again, do a study to see what threshold level would eliminate a lot of invoices from the approval process, while still leaving some approval control over the really expensive ones.

Next, if the purchasing department already issued a purchase order, then that is an approval – and you don’t need any further approvals.

Third, buy an invoice stamp that says, notify the accounts payable staff only if you do not approve. All other invoices will be paid automatically.

Use this stamp on every invoice that you send out for approval. This is called negative approval. If you take this approach, which I strongly recommend, you’ll find that almost every invoice is automatically approved. It’s really quite an event when an approver does not want to pay an invoice. So this will cover nearly all of your invoice approvals.

And finally, what if you have an invoice that’s so expensive that you just have to get an approval signature on it? Don’t send it by interoffice mail. You may never see it again. Instead, walk it to the person who’s supposed to sign it, watch them sign it, and walk it back.

Yes, this is ridiculously time-consuming, but it also absolutely guarantees that it will be approved on time. And also, you’re standing right there, so if the approver has a question about the invoice, you can answer it on the spot. And besides, this method is the exception. You’re not going to be walking invoices around the company very much.

So, what we’ve done is target the two big time-wasters in the accounts payable process, and we’ve figured out ways to avoid both of them. You may not be able to completely eliminate either one, but avoiding them 90 percent of the time should be possible.

Related Courses

Lean Accounting Guidebook

Optimal Accounting for Payables

Payables Management

A Lean System for Cash Receipts (#137)

In this podcast episode, we discuss a streamlined method for handling cash receipts. Key points made are noted below.

The Nature of a Lean System

I don’t think there’s an industry-standard definition yet for what it means to have a lean accounting system. So I’ll make up my own definition, which is doing accounting with minimal resources. Getting to minimal resources can be quite a trick. This is not a matter of just installing a best practice somewhere in the system and hoping that your cost structure gets better. Instead, you need to look at the whole process and figure out the exact spot where a system change leads to a lean system.

Cash Receipt Improvements

Let’s work through this from the perspective of cash receipts. Specifically, let’s look at creating a lean system for check receipts. Now I won’t get into the whole procedure for check receipts. Let’s just summarize the work flow. A check arrives at your business, and the mailroom staff opens the letter, does some recording of information, and then passes the check along to the cashier. This person does some more recording in the accounting records, and matches it to what the mailroom staff recorded.

Then the checks and a deposit slip go to a courier, who takes it to the bank. The bank tallies up the checks and provides a receipt, which is later compared to what the company recorded. That’s it.

So what we have is checks going through the hands of the mailroom staff, the cashier, the courier, and the person reconciling information at the end. That’s four people, and that’s four ways to screw up the process. So when you look at it from the perspective of too many people being involved, the obvious best practice to install is a bank lockbox.

With a lockbox, customers send their checks straight to the bank. The payments never come near the company premises. What does that do to the process?

Well, the mailroom staff is no longer involved. And there’s no courier. And there’s no one reconciling information, since there’s no information. Instead, all you have is the cashier looking up check images on the bank’s website each day, and recording the information in the accounting records.

That’s lean accounting. We’ve gone from four people to one. Now lockboxes have been around since about the time of Adam and Eve, so this is hardly new. The difference is that you’re thinking through the impact on the business before you figure out which best practice to install first.

Now let’s take this a step further. The objective is not really the lockbox itself. The objective is shrinking the check receipts process. And just installing a lockbox does not really meet that objective. The trouble is that there’ll continue to be a trickle of checks being sent straight to the company, not the lockbox.

So to be truly lean, you have to keep reminding customers to send their checks to the lockbox. And you may want to have the mailroom staff re-mail any incoming checks to the lockbox. And on top of that, maybe the only measurement you need for check receipts is a detailed listing of the cash that still comes through the business premises every day.

And it’s the job of the accounting department to follow up on every one of those cash receipts to make sure that they all go to the lockbox in the future.

So let’s get back to the concept of lean again. The objective is shrinking the check receipts process. You may realize now that just installing the lockbox doesn’t complete the objective. Instead, you have to do the installation, and then spend months going after every single check that still arrives at the business. As long as any check is processed within the company, you have not attained that objective, which means that the old procedure is still there, and you don’t have a lean process.

Now, what if someone says that lockbox fees are too expensive, and so don’t do it?

Well, there are other best practices that can still shrink the overall process, but it’ll still be longer than what you could do with a lockbox.

For example, you could install check scanning equipment, where you scan checks and basically e-mail a batch file of your deposits to the bank. Yes, this eliminates the courier, so the process is shorter. But checks are still moving through the company, and that means you still need to have a bunch of controls to monitor the checks.

Or, as another example, there tends to be a bottleneck at the cashier. This person may want to apply check payments to open accounts receivable, and wants to hold onto the checks until all of the cash is applied. If they have a problem applying cash, then they may not send a deposit to the bank. You can avoid this bottleneck by making photocopies of all the checks and applying cash from the photocopies. This allows the checks to be deposited faster.

Now these are two examples of ways to arrive at a somewhat more lean check receipts process. But the trouble is that you’re still accepting the fact that checks will be on the premises. And that’s the key item that has to go away.

So what do we get from this way of thinking? First up, consider the entire process flow to figure out which parts can be changed or eliminated. Then implement just those changes that allow you to alter the process. And then follow through over and over again to just beat up that implementation, so that you never have to return to the old system.

And doing it this way also means that you only have to install a relatively small number of best practices. To go back to my examples, if you revise checks receipts the right way, you only have to install the lockbox. Once there aren’t any checks running through the business, there’s no need to install check scanning equipment or make photocopies of checks.

Related Courses

Lean Accounting Guidebook

Optimal Accounting for Cash

Goodwill Impairment Testing (#136)

In this podcast episode, we discuss a new accounting standard for goodwill impairment testing. Key points made are noted below.

Background on Goodwill Impairment Testing

This episode is about the new Accounting Standards Update about testing goodwill for impairment. If you do acquisitions, this might apply to you. First, for some background. Under GAAP, you record a goodwill asset when you make an acquisition and some of the amount paid can’t be assigned to specific assets or liabilities. This happens most of the time. Then you’re supposed to test the goodwill asset every year or so to see if any of it should be written off. The way you’ve been required to test for goodwill - up until now – is a two-step process. First, you compare the fair value of a reporting unit with its carrying amount on the books, and if the carrying amount is greater than the fair value, then you go to the next step, to figure out the amount of the impairment loss. If not, then you’re done and there’s no impairment. In the second step, you measure the amount of the impairment loss, which is what you’re going to write off. I won’t get into the details of how the second step works, since the rules change doesn’t impact it.

Enhancements to the Testing Process

Now – the folks at the Financial Accounting Standards Board have been hearing some complaints about the “cost and complexity” of that first step. So they’ve decided to change the testing requirement. Under the new approach, you have the option to change the first step in the impairment testing process. Now, you can run through some qualitative factors to decide if it’s more likely than not that the fair value of a reporting unit is less than its carrying value. If so, then you still have to complete the original first step, which was to calculate the fair value of the reporting unit. And in case you’re curious, the more-likely-than-not threshold is defined has having a likelihood of more than 50 percent.

Qualitative Factors

So what are these qualitative factors? Well, the FASB is being pretty open-ended about it. What they state is what they call “examples” of events and circumstances that should be assessed. That means you should consider what they list, but you could use other factors, too.

There are seven of these “examples,” and some are pretty broad. The first is as broad as you can get.

It’s macroeconomic conditions, such as a deterioration in general economic conditions, or fluctuations in foreign exchange rates.

The second example is the same thing, but at the industry level, so now it’s a deterioration within the industry, or an increasingly competitive environment, or changes in the regulatory environment.

Then we get into cost factors, such as an increase in the cost of goods sold that negatively impacts profits.

The fourth example is a decline in overall financial performance, such as declining cash flows or a declining trend in revenues or profits.

Then they change gears and get a bit more specific in the fifth example, which is changes in management or key employees, changes in customers, new litigation, and so on.

The sixth example involves major business events, such as an expectation to sell the reporting unit.

And the last example is a sustained decrease in the share price, both in absolute terms and in relation to the share prices of competitors. This last example obviously only applies to public companies.

When you go through this analysis, you’re supposed to place the most emphasis on those factors that could affect the fair value of the reporting unit. And whatever you decide, you certainly need to document it thoroughly, since the auditors are bound to review it.

That’s how the new variation on impairment testing works.

Whenever you want to do an impairment test, this new approach is always available as an option. So if you don’t elect to use it one year, it’s still available for use in a later year.

Now, why do we bother with this new variation? Because under the old approach, you may have to hire an appraiser to determine the fair value of the reporting unit – which can be expensive. With the new approach, you can potentially avoid the expense.

And the time needed to do the qualitative analysis probably goes down after the first year, since you’ll only have to update the documentation you already created in the preceding year.

On the other hand, this can lead to some pretty mushy impairment evaluations. A lot of businesses could potentially use this approach to avoid impairment charges; so I would expect some businesses to come up with documentation for some pretty rosy outlooks.

So, the net result of all this is a reduced level of effort for impairment testing, and I would guess at a reduced number of impairment charges, too.

And by the way, this standard applies to both public and privately-held businesses. Also, this approach is only available under GAAP. It is NOT available under International Financial Reporting Standards. In fact, this creates a greater divergence between the GAAP and IFRS accounting for goodwill.

Related Courses

Business Combinations and Consolidations

GAAP Guidebook

Mergers and Acquisitions

How to Fine Tune Your Control System (#135)

In this podcast episode, we cover a number of options for altering your control system to yield better results. Key points made are noted below.

The Range of Controls

Control systems tend to be at either end of a continuum, which is practically no controls at one end, or so many controls at the other end that you choke on them. Most companies begin with too few controls, because the founders are just trying to start the business, and having the right controls is about number 500 on their priority list.

You usually get too many controls when a company hires in a controls consultant to upgrade the whole system, and they go wild. The same thing happens when a company hires in a controller who used to be an auditor, and the same thing happens – they go nuts and add controls everywhere.

In that latter case, they may be using a standard list of controls, which you might think is acceptable, especially if it comes from some well-known organization. The trouble is, that kind of a list is designed to be comprehensive, so it contains every bloody last control on the planet. And another problem is that it’s designed for some generic company in a generic industry – not for your company in your industry.

So those are the two extremes. Being in between those extremes doesn’t necessarily mean that you have a nice, balanced control system. It may mean that somebody added a few controls here and there in response to a problem, like a case of fraud, or a customer not being billed.

So, what I’m saying is that you might be at either end of the control continuum, or in the middle, and the system still may not work. You may have too few controls, or too many controls, or not the right controls.

A lot of this mess comes from the attitude that people have about controls. They think of it as an annoyance. So they only deal with it when they have to, which usually means when something breaks down or the outside auditors complain about it.

How to Improve Your System of Controls

How do you turn this around and arrive at the right set of fine-tuned controls? It helps to look at your controls from a series of different perspectives, and tweak the system based on each one of those viewpoints.

Now believe it or not, it helps to think of a control system as sort of a profit center. This may sound odd, because controls clearly cost money. So where’s the profit?

Well – first of all, please keep in mind that I’m not advocating actually creating an income statement for your control system – good luck with that. But you can quantify some of the risk that you’re trying to mitigate.

For example, let’s say that you think buddy punching is going on. This is when an employee doesn’t come to work, but his buddies punch his timecard for him. There’s a pretty clear cost associated with that, since you’re paying someone who isn’t there. So in this case, you can offset the cost of installing a biometric timekeeping system, which eliminates buddy punching, against the presumed losses from buddy punching.

So the profit center approach is going to account for some of the controls that you need.

Now let’s view this from a different perspective, which is the concept of the cost per occurrence. What if someone could get into the treasury system and wire all of the company’s cash to a foreign bank? It might only happen once every hundred years, but when it happens, the company is toast. So because the cost per occurrence is so massive, you have to add a bunch of controls involving wire transfers.

Let’s take the other extreme of that concept. What if the cost per occurrence is just a few dollars? For example, the office manager locks up the office supply cabinet to keep pilferage down. Do you really need that, or is it just irritating? If you look at controls from this perspective, there’s not much point in annoying people by protecting against a low cost per occurrence. Instead, skip the control and accept those piddly little losses.

So we’ve now viewed controls from two perspectives – profit center and cost per occurrence. Let’s view them from a few more angles.

Next up is repetitiveness. If you have certain transactions that happen every single day, then you should spend a lot of time thinking about the right controls for them. If a transaction only happens once a year, it’s quite all right to wing it and not prepare some complex system of controls for it. Though, that’s also subject to the concept of cost per occurrence. So if you only do one wire transfer per year, you still want some good controls.

You might look at repetitiveness from the perspective of a Pareto analysis. That’s the concept where 80% of the transaction volume of a business probably comes from 20% of the transaction types. What you want to do is concentrate on having goods controls for that high-volume group of transactions, and not be so concerned about the rest.

OK, let’s look at a fourth perspective. This one is about creating accurate financial statements. You want just enough controls to make it likely that the financial statements you produce contain no material errors. Some controllers really have a problem here, because they want the financials to be perfect, and that requires a preposterous number of controls. But the more controls you add to the accounting system, the more time – and money - it takes to create financial statements.

So those are four perspectives you should take when reviewing controls. But you’re not done yet. Because there might very well be overlapping controls. You might have installed one control to make the financials more accurate, and a separate control to handle a high-volume transaction, and it turns out that one control could cover both areas. So you need to look at overlaps and very selectively prune out those controls that are redundant.

Let’s bring all this together. I just pointed out five ways to view controls. And you need to use all of them to figure out which controls you need. But doesn’t that seem a little discombobulated? How do you organize this?

The first step is to document the highest volume processes you have, and the result should be a good, clean set of flowcharts. Then adopt a layering approach, where you go over those flowcharts based on each of the perspectives I just talked about. So, for example, go over the entire system from the profit center viewpoint, and then go over it again and view it from the perspective of cost per occurrence. And so on. And after you’re done, then go back and look for overlaps.

Are you done yet? No. Have the auditors look at what you’ve developed, or hire a controls consultant. You don’t want them to design your system, only to review what you’ve done. If you have them design it, they always install too many controls, without really understanding your business. So you just want them to look for holes in the system.

All of that work covers your first pass at the control system, and it might start out as a good system. The trouble is that any system starts to degrade immediately, because the underlying processes change all the time. So you need to address two more items.

The first is to arrange to be notified when any business process is altered. This usually means staying in touch with the IT staff, since they do the programming changes, or it might mean staying in close touch with all of the department managers. Whatever the case may be, you need to know when the system changes, so that you can change the controls to match the system.

And the second item is creating an error reporting database. Whenever any screw up occurs, employees have to log them into the system. And then you keep reviewing the database to see what’s happening that might be fixable by tweaking the controls.

And that covers how to fine-tune your control system. But that’s only the mechanics of how to do it. There’s also a mindset issue to consider. If you treat the control system as an annoyance, then you may go through the steps I just described, but you’ll only grudgingly do it. That’s not the way to look at it. Controls really are important. While they may seem to interfere with a lot of short-term work, they can keep a company out of a lot of trouble, and they can save money, too.

So the proper controls mindset is to block out a good chunk of time to close your door, put your feet up on the desk, and think about controls – and do it every couple of months. Even if you don’t change anything, you’ll at least get in some good meditation time.

Related Courses

Accounting Information Systems

Accounting Controls Guidebook

Adding Value to Internal Audits (#134)

In this podcast episode, we discuss how to improve the results generated by internal audits. Key points made are noted below.

When you conduct internal audits, there’s going to be a report at the end, and that report contains findings and recommendations. How do you get the greatest implementation value from that report?

Selecting the Right Topic

Well, the first issue is making sure that you have the right topic that someone wants to implement. And this is the key issue in internal auditing – planning up front to do the right projects. Now, if you listen to the outside auditors, the only role of the internal audit staff is to monitor a “robust” system of internal controls. And of course, to help them conduct their annual audit.

But does that mean you’re adding value? Well, if the internal audit staff is doing work that reduces the workload of the outside auditors, and that reduces the fees of the outside auditors, then there you go – you’re adding value. But let’s get real here. First, the audit only happens once a year, or maybe there’s a quarterly review if the company is publicly held. So what does the internal audit staff do the rest of the time?

So let’s focus on that other part of the year when there’s no audit to support. And again, we’re talking about adding value. There are a few ways to do that. One is to take a bit of a different view of controls auditing. Rather than trying to create a “robust” system of controls, which I think means an “oppressive” system of controls, what about creating a “streamlined” system instead?

A Focus on Streamlined Controls

In this case, the trick is to not overload the company with too many controls. This is not easy, since you have to judge the risk of eliminating a control. But think of what that means to the concept of adding value. It means that the internal audit staff looks at the whole company not as a system of controls, but instead as a system of business processes that it should help make as streamlined as possible.

This doesn’t always mean eliminating controls. It could mean shifting them around or automating them so that they’re less intrusive. And think of how easy it is to implement a streamlining suggestion. Of course it will be installed. And that’s a way to add value.

The Internal Auditor Liaison

Another way to add value is to assign each internal auditor to be a liaison with a department manager. If you’re an internal auditor and you’re a liaison, that means you set up a meeting on regular basis to meet with that manager. Let’s say it’s once a quarter. And your job in that meeting is to listen to the manager and find out what kinds of problems there might be that the internal audit staff can help with.

By doing this, you reorient the concept of the internal audit function. Instead of turning up unexpectedly and rooting around for problems, you are asked to come in and help with a specific problem.

Now, there will be times when you do show up unexpectedly, especially if you’re investigating a report of fraud. But the rest of the time, with this approach, adding value is easy.

Addressing Risk

But it doesn’t mean that the internal audit department turns into some kind of public service function. There are some areas where there is risk, and you need to examine those areas from time to time. So this concept of adding value to internal audits – to some extent – becomes a scheduling issue.

You need to create a mix of reviewing high-risk areas, and doing fraud investigations, and so on with the work requests being funneled back through the liaisons.

The Internal Audit Feedback Loop

And the more work the internal audit does that’s being requested by the various department heads, the more it gains their confidence, and therefore the more requests they make, so you end up with this feedback loop that keeps increasing the types of projects that add value.

But again, you need to do the other types of work too. So this is where some marketing comes in. It might be useful to have an internal audit newsletter that goes out to the rest of the company. And in that newsletter, you talk about the ways in which the department has been helping the rest of the company, and talking about projects completed, and results achieved, and so on. This means that you’re making the company disproportionately aware of the department’s role in certain activities, while still fairly quietly working on other projects, too.

Follow-Up Audits

So far, I’ve been talking about adding value through the carrot approach – which is to make the rest of the company like you more. There is also the stick approach, where you tell senior management which departments have not been implementing your recommendations, and ask to have the offending people thumped on the head. If you follow this path, then there need to be follow-up audits to see if the initial recommendations were implemented.

The stick approach is not popular, but it is still needed. There will be times when you make an unpopular recommendation, probably to mitigate a risk, and it causes extra work. So of course no one wants to implement it. Still, it has to be done, and knowing that the auditors will come back later to check on the situation is important.

So, does this carrot approach of streamlining controls and helping departments essentially turn the internal auditing department into an internal consulting department? To an extent, yes. But it’s just a matter of emphasis. The overall mission of the department remains the same, but it’s easier to add value to the work it does. And keep in mind that you need to mix in the stick approach too, to make sure that the tougher recommendations are also implemented.

Related Courses

Internal Auditing Guidebook

Accounting for Marketing Expenses (#133)

In this podcast episode, we cover the various rules relating to how you account for marketing expenses. The key points are noted below.

This episode is about marketing expenses. I’m responding to listener’s question, which is: When are marketing creative costs, such as for designing promotions, packages, and point-of-sale, expensed? The question goes on with an example, which is, if these costs were incurred last year, but the related marketing program hits in this year, in which year do you charge the expense?

Accounting for Advertising Expenses

The best answer to this is under Generally Accepted Accounting Principles, in an area called Other Expenses in the accounting codification. There’s nothing about it at all in the International Standards. What GAAP talks about is advertising expenses, which is really a subset of marketing expenses – and the question was about marketing expenses. So I’ll go over what GAAP has to say about advertising, and then we’ll extrapolate back to the question from there.

So. GAAP says that you have two kinds of advertising expenses. The first is the cost of producing advertising, and the second kind is the cost of communicating the advertising. The part we’re interested in is the cost of producing advertising, since that most closely relates to the question about marketing creative costs. Under GAAP, you charge the cost of producing advertising to expense as you incur it, no matter when the actual advertising associated with it actually occurs.

OK, that gives us some good detail on the issue. I would say that producing advertising is pretty close to designing the promotions, and so on, that were referenced in the question. And so it’s reasonable to say that the same rule applies. So, you should charge marketing creative costs to expense as soon as you incur them.

Other Marketing Rules

Now, while we’re here, let’s see what other rules there are regarding marketing.

There’s a rule that allows you to treat sales materials, like brochures and catalogues, as prepaid supplies. This means you can record these items as an asset, and then charge them to expense as you use them up. But, at whatever point you stop distributing them, you have to charge the remaining asset to expense.

I’ve done this, and it’s a pain in the ass. The trouble is that absolutely nobody is keeping a good count of however many brochures are still in stock. So, right in the middle of trying to close the books at the end of the month, you have to go off and count the bloody brochures, and figure out how many are gone, and how much to charge to expense.

And on top of that, brochures have a habit of sticking around for years, so you’re always in that gray area of whether you should write off the remaining stock or keep it on the books. So the accounting just drags on.

Without question, my advice is to not even bother. Unless the company is spending a massive amount on these materials, it’s so much easier to just charge it to expense as soon as you buy it.

Another issue is the cost of communicating advertising. You can charge it to expense as soon as you incur it, or when the first advertising takes place. And you have to be consistent in using one approach or the other.

Accounting for Direct Mail Advertising

Now, what about direct mail advertising? This is where you’re incurring a cost to distribute some kind of mail piece, and you expect a certain number of responses back. In this case, you can record the cost as an asset, but only IF you can prove there’s a relationship between the costs incurred and future benefits from the mailing. Mind you, you have to prove the relationship, which means using historical results for the same product or similar products. If you can’t prove that the mailing is going to generate revenue, then you have to charge the cost to expense right away. Of course, that brings up the issue of why you’re doing the direct mailing at all, if it’s not going to make any money.

Anyways, if you can prove a relationship, then you can record the cost as an asset and then charge it to expense as you recognize revenue from the direct mail campaign. And that means you have to prove the revenue came from the campaign, which means there should some kind of offer code included in the mailing that you can track.

And there’s actually more paperwork involved. You also have to segregate the cost of each direct mail campaign in a separate cost pool, and only recognize it as an asset if you can prove that historical revenue to expense relationship – and that’s for each individual cost pool.

So, should you go through all that grief just to defer the cost of a direct mail campaign by maybe a month or two? As usual, it depends. My normal knee-jerk reaction to this kind of annoying rules-making is to say no – just charge it to expense. And in fact, that is what I recommend. Especially if the direct-mail cost isn’t that high.

But, if you’re in the direct mail business, either following or not following these rules could have a material effect on your income statement. So in that case, I suggest modeling your results both ways, and consulting with your auditors. And if you’re already following this rule, you probably want to be consistent with past practice, and just keep doing it.

Related Courses

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Consolidation Software (#132)

In this podcast episode, we cover the basic requirements for consolidation software. Key points made are noted below.

When the request came in, I sent it along to a partner at a really large accounting firm, and she passed me along to a director who specializes in consolidation software. This seemed like a good thing. He wrote up some notes for the podcast, but then he had to have it reviewed by their legal department. And their attorneys said, no, he could not be involved. So, he passed along the notes, on the condition that I can’t say his name or the name of the accounting firm. Which was very nice of him, but just incredible that they don’t want their name involved. This podcast goes out to multiple thousands of listeners, so if this isn’t good marketing, I don’t know what is.

Consolidation Software Functional Requirements

So, let’s get on with the topic. The question was, what to look for in consolidation software. Our unnamed director listed the functional and technical requirements separately. Here we go with the functional requirements:

First, currency translation using multiple exchange rates. For example, you need the average monthly rate for the income statement, month-end rates for balance sheets, historical rates for selected investments, and management rates for budgeting purposes.

Next, we have intercompany reconciliation and elimination. This is where the intercompany balances and differences can be tracked by entity for quick resolution.

Next, alternate hierarchies. The system can provide data for multiple hierarchies, which can include statutory, management, and tax-related hierarchies.

Next, regulatory initiatives. The software should be able to do XBRL reporting for the SEC. And by the way, we talked by XBRL in Episode 108. This also means helping to do dual reporting for both the GAAP and IFRS frameworks.

Next, requirements for multiple accounting standards. This means maintaining data for local reporting purposes, and then modifying the data for the accounting standards used by the parent company.

Next, audit trail and adjusting entries. The system should provide detailed audit trails for all of the data collected, and it should generate automated adjusting entries.

Next, data categories. The system should be able to store multiple data categories, such as actuals, the budget, budget variances, and all of that.

And the last functional item is, reporting. This means a web-based drag and drop report creation system. You should also be able to set up a reporting calendar, which the system uses to create and automatically distribute reports. The system should also generate reports in PDF format.

Consolidation Software Technical Requirements

So that was the functional requirements. Next up, we have technical requirements.

First, workflow and task lists. There should be task lists for critical activities. I’ll just read this next part off his list. It says, if possible, there should be an ability to track activities that are scheduled to be completed outside of the consolidation system. For example, reconciliation of subsidiary ledgers is a critical closing activity that could be included in the task list and managed through the work flow process. Some tools offer the capability of entity-based certification from local controllers.

Next, we have the user interface. There should be a user-friendly front end for the collection and validation of data. And he notes that most consolidation packages offer interaction with an Excel front end.

Next up is data validation. There should be user-defined field validations at the point of data entry. This can be things like debits always equal credits, and net income on the income statement equals the current year profit or loss listed on the balance sheet.

Next is rule development. He’s listed this as being a self-service function, and I’m guessing this means you can develop your own macros in the system to automate some tasks.

Next is security. There should be security by module, which keeps users from getting access to data that they don’t need. This can also mean that you can read information in certain areas, but you can’t change the data.

Next is drill down capability. You should be able to drill down to the source data from the consolidation level.

Next is the allocation engine. There should be an easy-to-use allocation engine, which is used for allocating expenses across business units, regions, and so forth.

Also, there should be integration with spreadsheets. There should be quote unquote, “dynamic integration” of spreadsheets with the consolidation database.

And finally, there is system maintenance. You should be able to do system maintenance without having to log users out of the system.

Related Courses

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Operating without a Budget (#131)

In this podcast episode, we discuss how to operate a business without using a budget. Key points made are noted below.

In the last episode, I talked about how annoying and counterproductive the budgeting concept is. So in this episode, I’ll talk about how to get by without a budget.

The Need for a Forecast

The first issue is that you still need a forecast. Otherwise, nobody knows what’s coming. But it’s at a summary level, and it’s quick – really quick – and you update it a lot, like once a month. You don’t need to go into excruciating detail, like you would with a budget. Instead, this is simply an update on what you think might happen in the near future.

A couple of points on this. First, if you spend more than a half an hour on this each month, that’s too much time. The only way you’ll get people to issue a new forecast frequently is by making it easy to do.

Second point. How far in the future should you forecast? Only for as long as you’d use it to make decisions. So for example, if you’re building software apps, the market moves so fast that a three-month forecast is probably fine. Any longer, and you’re forecasting things that are bound to change. On the other hand, if you’re in an established industry where things don’t change much, you can extend the forecast. But not by too much. Only extend the time period out as far as the information is still useful.

Third point. Do not link it to anyone’s performance plan. If you do that, they just start messing with the numbers in the forecast to make themselves look good. All you want is a forecast that gives some warning to employees about what’s coming up in the near future. This is not designed to pay somebody a bonus.

Fourth point. You don’t actually need to revise the forecast once a month. If nothing has changed in the past month, then there’s no need for a new forecast. So in some industries where things don’t change much, just keep trucking along until something happens that warrants an update.

Ok, so a short-term forecast is the first thing you need if there’s no budget. If you have it, you get rid of all that budgeting inaccuracy that I talked about in the last podcast.

The Timing of Capital Budgeting

The second thing you need is to revise the timing of the capital budgeting process. There’s no longer a need to only review capital budgeting proposals once a year. Instead, you’ll accept proposals whenever somebody needs to buy a fixed asset. But this doesn’t mean that you eliminate the review process. Fixed assets can be really expensive, so you still need to examine the larger proposals in a lot of detail. On the other hand, if there’s a really low-cost proposal for a fixed asset, you can back off and just buy it without wasting too much time. So, there’s just a minor tweak to capital budgeting needed if you want to operate without a budget.

How to Set Goals

The third thing you need is a different way to create goals for the business. You might recall from the last episode that a standard budget is basically one gigantic set of goals. But they’re fixed goals. You’re going after hard targets that are fixed in the budget for the entire year. Instead, the new concept is that you want to do better than you did before. That’s all.

It seems pretty simple, but actually it’s a bit more complicated than that. You can use benchmarking to figure out what the best in class is for whatever you want to improve. Maybe it’s how fast you can fill an order in a distribution company, or the time required toturn around an order in a fast food restaurant, or inventory turnover. Whatever it is, just figure out how well the better companies are doing it, and set up a goal.

You don’t have to reach the goal right away, but you want to do better than you’re doing now. The reason for leaving this so vague is that there’s no reason for anyone to game the system anymore, because there’s no internally-derived target for anyone to mess with. Instead, you could say that the internal average fulfillment time for an order is five minutes, and the best in class companies can do it in three minutes. And eventually, we’d like to get there. But we don’t have to reach that goal this year. We’ll get there when we get there, but there has to be progress.

The Need for a Reporting System

And you reinforce the goal setting with a really good reporting system. So pretty much everyone in the company sees reports that show current performance, and the goal that the company is shooting for. And along with that reporting system goes more responsibility.

Who Sets Strategy

Senior management still does strategic direction work, but most of the tactical-level decisions get pushed down much lower in the organization. That way, local people know what the current performance is, and they know what the goals are, and they can decide on how to get there. And that allows them to make changes really fast, if that’s what’s needed.

Changes to the Performance Compensation System

And that brings us to the fourth and final point, which is that you have to restructure the performance compensation system. Under the old approach, there’s a specific performance agreement with each manager, under which they’re paid a bonus if they meet certain very specific targets.

What you should do is eliminate all of those performance contracts. Instead, there should be one big bonus pool for everyone in the company, which is probably based on a chunk of the full year profits. And there’s a bonus administration group that figures out who gets how much of the pie, which is based on a fairly basic allocation formula.

So why would this approach be better, and why does it work if there’s no budget? First, everyone gets involved in the performance of the company, because everyone can get a bonus. And if you think that managers come up with all the good ideas in a company, think again.

Second, if the bonus pool is based on a chunk of profits, then improving performance means there’s going to be a larger bonus pool. And also, the size of the bonus pool is only known at the end of the year, so if the company has a bad year, no bonuses. That’s quite a bit different from the traditional approach, where a company may be required to pay out bonuses even if the company as a whole did poorly; and that’s because it signed off on specific bonus agreements that promised the payment of very specific bonus amounts.

And another reason for this type of compensation. What do you think the control environment would be like if every single employee was counting on getting a bonus? I think you end up having every employee acting like an internal auditor, and they’re all making sure that operations are done right, and that money is not wasted. Kind of an interesting concept.

Parting Thoughts

These concepts might sound idealistic, but they do get around all of the issues that I described in the last episode. And some companies are using them right now.

To do it, they’ve made some pretty major changes. Senior managers have to keep their hands off of day-to-day decisions, lower-level people need to be trained to run operations themselves, and there’s a whole different way to pay bonuses that might not sit too well with those who were paid a lot before. And you have to dismantle all of that bureaucracy that went with having a budget.

So that covers budgeting. In case I haven’t made it clear enough yet, I’m not entirely happy with the traditional style of budgeting. I think it wastes an amazing amount of time, and it’s inaccurate, and it supports a top-down style of management that doesn’t work very well in a lot of companies. Instead, trying cutting loose and operating without a budget. You might like the results.

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The Problems with Budgeting (#130)

In this podcast episode, we cover the multitude of problems with budgeting. Key points made are noted below.

I talked about creating and improving budgets in earlier episodes, but have you ever considered that you might not want a budget at all? They have a lot of problems. Let’s talk about why budgets can actually harm a business.

Budgets are Wrong

The first issue is that the blasted things are always wrong. You create a budget around the end of the year, and it’s based on fairly good predictions of what will happen in the next couple of months, and then things get pretty dicey after a few more months. This can be really bad in an industry where there’s lots of upheaval, and less of a problem when you have lots of long-term contracts or the competitive environment is stable. Nonetheless, even in the latter case, the budget will eventually depart from reality. I’ve been doing budgets for a long time, and almost all of them could be classified as science fiction by the time we reached the end of the budget year.

You just cannot predict events perfectly. This has two bad results. The first is that variances from the budget keep getting bigger as the months go by, to the point where people start to ignore the budget. And second, people tend to look upon budgeted expenses as money they can spend – but what if actual revenues are lower than expected, but you’re still spending money according to the budget? Then the company loses money.

Budgets Require Revisions

Another problem with the budget is that managers get into the mindset of only doing planning once a year, for the budget. But what if the industry is changing so fast that you have to keep updating strategy every few months? If management has that annual planning mindset, it’ll keep right on using that annual budget, even though you should scrap it.

Budgets Take Time to Construct

And here’s another problem. What about the time required to construct it? You can put a bunch of people on it for months, and managers have to provide their input, too. And then you go through God only knows how many iterations to fine tune it. And, for what? If you evaluate what a company does with its budget, a lot of the time, it’s not worth the effort.

Budgets Allow for Gaming the System

And then we have the problem of gaming the system. This means that managers know they’re going to be evaluated based on how well they perform against the budget. So, doesn’t it make sense to predict really low revenues and really high expenses? That way, you’re bound to look like a hero. Of course, it also means that the budget is wildly conservative, and it also means there’s not much of an incentive to push the organization to perform better.

The Use it or Lose it Problem

But we’re not done yet with budgeting problems. I’m just getting warmed up. The next issue is the “use it or lose it” syndrome. Everybody knows that if you don’t spend every last cent in your expense budget, you’ll be assigned a smaller budget the next year. So that means managers spend money like crazy in the last month of the year, even if they don’t need to. This is why December is such an unprofitable month for so many companies.

Problems with Capital Budgeting

And then we have capital budgeting. The trouble here is that you plan for all of the fixed asset purchases for the next year during a few weeks at the end of the preceding year. So everyone submits their proposals, and the winners have their expenditures built into the budget.

OK, but what if you have an unexpected need for more fixed assets sometime later in the budget year? You’ll probably buy them, and that means you’ll spend more money on fixed assets than you expected. In fact, it means you absolutely always spend more money on fixed assets than you expected. The reason is that a pre-approved fixed asset will be bought, and it’s usually bought earlier in the budget year. Therefore, expect to need more cash than you expected for fixed asset purchases.

Command and Control Problems

And then we have the biggest problem of all, which is the command and control system. This is the very common management system where the senior management team makes all of the large decisions, and everybody else implements them. When you have a command and control system, the “control” part of the equation is the budget.

The senior management group creates a performance contract with every manager in the company, where it hands out bonuses only if managers meet their expected performance – and that performance is detailed in the budget. Now, if you think the command and control system is fine, then you’re thinking, so what’s wrong with that?

There’re several problems with that. First, there’s that gaming the system issue that I just talked about. Budgets will be conservative, so that managers can make their bonuses. Count on it.

Second, people defend their budgets ferociously, so it’s really hard to shift money into new lines of business. This means that a business with a command and control system becomes rigid – it can’t react quickly to new opportunities.

For example, what if you’re a manager, and you see a hot new opportunity. But getting the money to pursue it outside of the normal budget process requires all kinds of approvals. Chances are, you won’t bother to spend the time getting a special dispensation, and you’ll wait until the next budget year to get funding for it. And by that time, the opportunity may have passed.

And on top of all those problems, you have ethical issues. If a manager is not quite going to make his numbers, and therefore won’t be paid a bonus, do you think there’s maybe just a little temptation to bend the rules to create better results? Yeah, just maybe.

Finally, command and control systems are both expensive and self-perpetuating. You need a budgeting staff, as well as people who run around and figure out why there’re variances between actual and budgeted results, and who generally try to keep the company running in accordance with the budget. And, these people obviously have a vested interest in maintaining the budgeting system, if not expanding it. After all, if there were no budget, they’d have no jobs.

So that covers the masses of problems with budgets. In the next episode, we’ll talk about how to operate without a budget. That episode might be delayed a few weeks, since I’m trying to fit in an interview on a different topic – so, stay tuned on that one.

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Streamlining Payroll, Part 4 (#129)

In this podcast episode, we finish up with the best practices that can be applied to the payroll function. Key points made are noted below.

So, in the first three parts, we talked about cutting back on the amount of data to collect, automating data collection, reducing the number of deductions, adding self-service, streamlining payroll calculations, and using electronic payments.

The Order of Priority

What order should you use to install all of these changes? I have some suggestions that give priority to immediate, low-cost improvements. And the reason for this priority is that you want to build a reputation for being able to complete projects, so cranking out a few easy ones might give you the internal support for a bigger change later on.

I think the first item to fix is to get rid of any excess data that’s being collected.

The main reason is that there’s no new system to install. You’re simply stopping the collection of information. That means everybody throughout the company is wasting less effort on recording information. And that makes folks pretty happy, which in turn means that they may be more willing to listen when you install the next change.

And also, the impact is immediate. The company stops recording information, and the payroll staff immediately has less work to do.

My suggestion for the second most important item is error monitoring. And again, this is partially because it’s a relatively quick fix and it can have an immediate impact on the payroll department. When there’s a payroll error, it takes an amazingly long time to fix. So if you can start collecting error information and fix even a few of the underlying problems, this is really going to help.

Third in priority is payroll cycles. If you can extend from weekly to any longer payroll cycle, then do it. And furthermore, put the entire company on the same payroll cycle. Obviously, this saves the time of the payroll staff, but it takes longer to implement.

You have to convince the other managers to do it, and notify everyone, and possibly arrange for advances for some of the staff. So, it’s a good improvement, but the delay in seeing results puts it a ways down on the priority list.

After that, I suggest automating time keeping as much as you can. This means spending some money on equipment or software, and training employees in how to use everything. So, because of the investment and the time required, I put it rather far down the list. But it’s still something you should get to fairly soon.

Next up, do electronic payments. Employees love it, but the net impact on the accounting department is not that large. When you switch from checks to direct deposit, it’s not like there’s a huge decline in the payroll work load.

And finally, and really dead last, is self service. You’re going to pay for this feature, either by programming it yourself or renting it from a software provider – so there’s going to be a cost that you have to balance against the benefit of shifting some data entry outside of the payroll department. For smaller companies, this may not be an overwhelming cost-benefit tradeoff.

Now, keep in mind that you can alter priorities based on your circumstances. So if you have thousands of employees, having self service might be really cost-effective – even though it was my lowest priority recommendation. It just depends on the circumstances.

The Level of Technology to Acquire

I also have a suggestion regarding the level of technology that you buy into. And this mainly refers to timekeeping hardware and software. All of the technology you need for a nice, solid system has been on the market for years. That means you don’t need to take a chance on some new and unproven technology, and especially from a new supplier who hasn’t been in the market for long. If you buy something that’s been used for a while, and which appears to be getting good supplier support, with plenty of upgrades, then that’s a good choice. This doesn’t mean that I’m a reactionary old dinosaur; it’s just that you want to develop a reputation for successful projects, and having some technology crash on you is not a good way to develop that reputation.

And once you have a system upgrade ready to go, don’t roll it out everywhere. Instead, do a pilot test, correct any problems you find, then use a larger test, and then roll it out. Does wonders for your reputation if you only crash and burn during a small pilot test. And this doesn’t just apply to technology. For example, if you’re getting rid of some data collection, you could have just a few people stop doing it, and see how that lack of information impacts the rest of the company. And if no one complains, then roll it out everywhere else.

For example, a bunch of years back, I was paring back on data collection, so my team yanked out a couple of data items. And then found out that we had just completely screwed over someone who used that information for some pretty critical reports.

Stagger the Upgrade Projects

Another issue is to move around your upgrade projects. The reason is that people don’t want too much change. It disturbs their routines. So, if you can, implement a change in one part of the payroll department, and then deliberately give those folks a break for a few months while you do an installation somewhere else, and then come back and do another project. Makes people a lot less unhappy.

Parting Thoughts

I’ll finish with a few thoughts on how all of these changes impact the payroll staff. Under a traditional payroll system, there’s a lot of data collection and data entry – and that’s pretty boring work, to say the least. A lot of what I’ve been talking about over the past few episodes has been to either eliminate that data entry, or to have employees outside of the department do that work themselves. That means the payroll staff ends up monitoring the information that everybody else entered – and they’re looking for errors, and missing information, and so on. That means you essentially shift out of the data entry business and into the data analysis business.

It’s very likely that the payroll staff will prefer the change. The work is certainly more interesting, but on the other hand, some people may be uncomfortable with the change of focus, and you’ll have to replace them. Will there be fewer people in the department? Maybe. It depends upon how large a group you have in place already. If it’s always been a smaller group with a strong knowledge of payroll, I would expect no staff changes. But if there was a large data entry group – then yes, there will be a staff reduction, and you may also end up upgrading to employees with a higher knowledge level.

Related Courses

How to Audit Payroll

Optimal Accounting for Payroll

Payroll Management

Streamlining Payroll, Part 3 (#128)

In this podcast episode, we continue with the discussion of best practices that can be applied to the payroll function. Key points made are noted below.

So, in the first two parts, we talked about cutting back on the amount of data to collect, and automating data collection, and reducing the number of deductions, and adding self-service.

How to Streamline the Payroll Calculation

Now, let’s talk about streamlining the calculation of payroll. This is not one of the better areas for streamlining. If you have payroll software, or if you outsource it, the systems are pretty good these days. As long as you input the information correctly, then payroll processing is easy.

The Handling of Commissions

But there are still a few holes. For example, part of that calculation bit involves calculating the commissions for the sales staff. And that can be ugly. We’d all like to see a nice, easy commission percentage based on sales or cash receipts, and which never changes. What we get is all kinds of – well, I guess the sales manager would call it – enhancements to the commission plan. I call it a royal pain.

So what we see all the time is the sales manager adding retroactive commission bonuses if someone meets a quarterly sales goal, and another retroactive bonus if they meet an annual goal, and special rates for selling certain products, and commission splits. For the accountant, this is basic seventh level of Hell stuff. And especially when you have to calculate all of it within just a day or two. And especially when the sales manager finds all kinds of errors and wants you to redo everything. So, what can you do?

Well, obviously, complexity reduction is the goal, but how do you get there? One option is to buy incentive compensation software, which cranks out the commissions for you. It’s expensive, but if the sales manager really wants this kind of commission structure, you can have the CFO demand that the sales department pay for the software.

That’s one possibility, but it’s also so expensive that you won’t be able to afford it unless you have at least 100 salespeople. Another possibility is to take the pressure off the accounting staff, and just the sales manager that the commissions are too complex, and so it’s going to take an extra payroll cycle to get the payments out the door.

This does not go over too well, but it does give the message to the sales manager that the system is getting too unwieldy, and you’re not going to pay overtime to the accounting staff just because the sales manager likes complicated commission plans.

Or, another option is to charge the sales department for all of the processing time by the accounting staff. This also will not go over too well – but if the sales manager gets a bonus based on the total expenses incurred by his department, it might get his attention.

Or, perhaps the best option is good old fashioned diplomacy. Try to get on good terms with the sales manager, and point out which parts of the commission plan are really giving you heartburn, and see if you can have those pieces removed. Keep in mind, the sales manager is concentrating on increasing sales – not on keeping the accounting department happy – so don’t expect miracles.

Error Tracking

Now, the payroll person who’s responsible for all of the processing is going to find an error from time to time – and probably on a preliminary version of the payroll register. So, they correct the error and run the payroll again, and check it for errors again, and so forth. Pretty standard stuff. That’s understandable. But what they should be doing is dropping every one of those errors into a database.

This could be a simple spreadsheet. Nothing fancy. What you want to do is let those errors pile up for a while and classify them by type. Then see which types keep coming up. This means you’re not concentrating on the outliers, just on the ones that keep coming back to haunt you. Focus on fixing whatever is causing those errors. Chances are, you’re looking at maybe a half-dozen really deep-seated issues that are going to take some time to fix. But once you get them, all you have left are the outliers that don’t happen very much. And you can pick them off last.

Using a Backup Person

And one other suggestion for payroll processing. This is one of the more complicated payroll functions, so of course you have your most experienced people in charge of it. But, what about a backup person? Everybody goes on vacation sometime, and when they do, you have to drop a backup person into payroll processing – and that’s when you really see a bunch of errors.

The solution is to designate a backup person, and involve them in doing an error check on the payroll register as part of every payroll. That way, you get two things done at once – you have a second pair of eyes looking for errors, and the person doing that review will become more familiar with the payroll system, and will do a better job of filling in.

Use Electronic Payments

OK, enough on payroll processing. Let’s move on to paying employees. The main goal here is to not use checks. We don’t like checks, because they take too much time to process, and they require a lot of controls. And, because there’s a great alternative.

The alternative is electronic payments. Now this is not just paying someone electronically. We’re also talking about no longer sending them a pay stub – and for those of you who like larger words, that’s also called a remittance advice. Instead, we send employees an e-mail that directs them to a secure web site, and on that site is not only their most recent pay stub, but all of them. This means that if you have employees badgering you about getting them a copy of a pay check or a pay stub so that they can apply for a loan, you can direct them to the web site and they can get it themselves.

As for electronic payments, there’re two ways to do it. The older system is direct deposit, where payments go directly into employee bank accounts. There are two problems with it, which are not large ones. Employees have to have a bank account, so that you can put money in it. And second, because of something called pre-noting, the first payment to an employee will probably still be with a check.

You can get around both problems by using the other approach, which is a payroll debit card. This means that you load up a debit card with an employee’s net pay, and they go off and use the card. There are some concerns with this approach because of bank fees and where you can use the cards.

But basically, I don’t care. The main point is to get off of checks and onto some form of electronic payment. If you can do that, along with the improvements that I talked about in the last two episodes, then you essentially have a perfect, streamlined payroll system from beginning to end.

Related Courses

How to Audit Payroll

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Streamlining Payroll, Part 2 (#127)

In this podcast episode, we discuss additional best practices that can be applied to further streamline the payroll function. Key points made are noted below.

Last time we talked about shrinking the amount of payroll information you collect, and the tracking of errors, and cutting back on the number of payroll cycles. So now we’ve cut back on the amount of data to collect.

Automate Data Collection

The next step is to automate the collection of the remaining data that we absolutely have to collect. The best way to do it is either with computerized time clocks that are in a fixed location, or with ones designed for mobile users. These have been around for a while, so I’ll be quick. A computerized time clock is in a fixed location, and people run their employee badges through it to clock in or out. If you have a lot of employees in one place, you’ll either need to buy a bunch of these clocks, or stagger employee start and stop times. Otherwise, they end up forming a big queue in front of the clock, and you will hear about it. This type of clock checks every scan to make sure the employee is checking in or out at the right time, and sends the information to a central database. You can also run error reports whenever you want.

For mobile employees, you can either create or buy the same type of system, but it operates through a secure website. If employees can get access to the Internet, then you’re good to go. These generally work with smart phones, too. And there’re some variations on this concept that work through the phone system, but you get the idea. The main operational difference between the fixed and mobile time clocks is that there’s no scanner for the mobile version, so you have to enter your time by hand – and that can cause errors that you wouldn’t see with a fixed clock. So that’s a quick overview of time clocks. They have two really nice features. First, employees enter their own time, and the system flags errors.

That pretty much wipes out the pure data entry part of the payroll department. It doesn’t mean that it’s entirely gone; just that the payroll staff becomes more concerned with monitoring what other people are entering in the system. Then the payroll staff keeps track of the errors that crop up, or conducts some extra employee training, or maybe improves a procedure somewhere. The point is that data collection work is now replaced by process monitoring.

Reduce Employee Deductions

So now the detail-level payroll information is in the computer system. What else can we do in the way of streamlining?  One good place to look at is employee deductions, which we can tackle in several pieces.

The first piece is employee advances. When an employee wants to receive an advance, the payroll staff has to cut a manual check, and record it in the accounting system, and then deduct it from the next regular paycheck – and maybe over several paychecks. In short, it’s a pain. And it tends to come up with a just a few employees, who basically treat the company like their own private bank. So what can you do?

This is a tough one. You can just shut down all advances, but you might get a backlash from the employees. One possibility is to charge a fee to any department manager that approves an advance. This is an interdepartmental charge, so there’s no cost to the company as a whole. That at least makes a manager think about it before approving an advance. Another option that doesn’t work very well is to direct employees to the local bank for a loan, but they’re probably coming to the company for an advance because they can’t qualify for a loan.

Another deduction item is employee purchases. A company may get some good discounts through its suppliers, and it allows employees to make purchases through the company. That’s fine, but do not let them pay the company back through payroll deductions. Instead, make them pay for it up front.

Yet another deduction item is benefits. There can be a lot of benefit deductions, such as for medical insurance, dental insurance, life insurance, and so on. This can be quite a chore to keep track of. One option is to increase the deduction on one benefit, like medical insurance, and provide another benefit, like dental insurance, for free. If you do it right, the net impact on the company and on the employees is zero, but now there’s one less deduction to keep track of.

Or, you could work with the human resources department and create a single benefit package that has a single deduction. Now, in reality, that single benefit package will have different deductions, because the benefit cost varies depending on the number of dependents on your insurance. Still, this can cut way back on the number of deductions you need to track.

Streamline Vacation and Sick Time Tracking

And moving on from deduction tracking, have you considered the tracking of vacation and sick time? Employees are mighty particular about a mistake in their unused vacation time and sick time, and that means you spend a lot of effort making sure that it’s right. How about merging the two together, and calling it all vacation time? That cuts in half the amount of data types to track. Now, this could have some employee push back, especially if you pay employees for unused sick time. So, it depends on the circumstances.

Implement Self-Service

So, let’s move on to self-service. This is when employees enter their own information into the payroll system for things like address changes, direct deposit payroll information, and payroll exemptions. That type of self-service is called employee self-service. There’s another flavor of this called manager self-service, and that’s usually for entering changes in pay rates.

If you outsource your payroll processing, it’s quite possible that your supplier offers an internet-based self-service module. If that’s the case, they’ll charge you a monthly fee for using it. If you have your own payroll software from an outside supplier, it might be available as a separate module. In either case, it’s much easier to find employee self-service than it is to find manager self-service. And that’s because it’s more cost-effective to have employee self-service, since you can shift far more data entry over to employees.

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Streamlining Payroll, Part 1 (#126)

In this podcast episode, we discuss the first of a series of best practices for improving the payroll function. Key points made are:

I’ve talked about payroll before, but only on some specialized topics. You can find payroll controls in Episode 14, and closing the payroll at month-end in Episode 24, and Payroll metrics in Episode 26. There’s also a discussion of payroll cycles in Episode 54. But I’ve never described how to streamline the basic payroll function. We’ll take care of that right now. And by the way, this will take a couple of episodes to get through.

How to Streamline Clerical Work

The main problem with payroll is that it requires a staff that has a pretty high knowledge of payroll regulations, but which is also willing to do an amazing amount of really low-end, detailed clerical work. And that’s an anomaly. What you want to do is streamline as much of that clerical work as possible, so that the payroll staff has more fulfilling work to do. Not only does this make the department more efficient, but it probably reduces the amount of staff turnover.

So how do we do that? Believe it or not, the first step is not to spend a pile of money on better payroll software or fancy computerized time clocks – though we will get that. Instead, you need to ask a simple question, which is – what information do we want to collect? In fact, if you change that question a bit more, the question really is, what information do we need to collect?

Minimize the Data to Collect

From the perspective of the payroll department, the only information you need is the number of hours to pay, and whether or not any of those hours are overtime hours – since they have a different pay rate.

Other parts of the company may want the payroll people to collect additional information, especially job costing information. So let’s say an employee works on four jobs during the day. He has to record start and stop times for each of those jobs, and also maybe the type of activity performed. And then the payroll staff has to wade through all of this extra information, which it doesn’t need. So what do you do? Well, it’s possible that someone wanted the job costing information for a special project.

If so, the project is going to be over with eventually, and as soon as it is, stop collecting the information. Or, the intent is to keep collecting the information for internal purposes, maybe for cost accounting. If so, it’s worth mentioning to whoever is sponsoring the analysis that this type of information doesn’t change much over time, which means that the information you collect has a declining level of utility over time. And that means that at some point, there’s no additional value associated with collecting the information. Or if they absolutely insist on collecting it, then how about doing it for a few weeks each year?

The point is the additional information requires a lot of work by the payroll staff, and it may not be much good to anyone else. So – why collect it? Now, what if you absolutely have to collect the extra information? Say it’s required under a government contract, or maybe you’re using it to bill the customer. OK, so you need the information. But can you decouple it from the payroll information? In other words, let the payroll staff only collect the information it absolutely needs to pay employees, and let somebody else collect all of the other information.

So that’s a key first step for streamlining the payroll department. It’s basically a one-time decision about whether or not to collect information. And if you can restrict that information, then it’s a massive up-front labor savings for the department. And, it’s the best kind of labor savings, because it’s annoying clerical work.

Reduce Data Errors

So now we’ve reduced the amount of data entry. The next problem to work on is data errors. There can be all kinds of errors. You’ve got missing start times and missing stop times, and the wrong person listed on a time record, or incorrect dates, and so on. Tracking down and fixing these errors takes up an amazing amount of time, so you really want to cut back on errors. But the trick is to not just dive into fixing errors. Instead, what you want to do up front is create a system for collecting and classifying types of errors.

So, let the errors pile up for a while. Then assign an error type to each error, and add up the quantity of errors of each type. Then figure out the amount of time it takes to correct each type of error. Now you have what you need.

You should only be spending time correcting the errors that happen a lot, and which require a lot of time to fix. By taking this approach, you can fix large numbers of errors at one time with a single fix, which is the most cost-effective use of the department’s time.

Once a lot of department time has been freed up, you can assign the staff to fixing errors that don’t occur at quite the same volume levels, and which don’t have quite the same impact on staff time. And that, in turn frees up more staff time for more error correction work, and so on.

So by this time, you should be collecting less data, and what you are collecting should be pretty free of errors. But it’s still possible to reduce the amount of data collection by shrinking the number of payroll cycles. I already addressed this in an early episode, so – very briefly – a payroll cycle is the time period from the beginning to the end of a pay period. So if you pay employees once a week, you have a weekly payroll cycle.

Use a Longer Payroll Cycle

Now, in that case, you’re collecting information for each payroll cycle, and checking it for errors, and summarizing it, and inputting it into the payroll system, and distributing payments to employees – and you’re doing it 52 times a year. 52 times! Now if you switch to paying employees biweekly, then you just cut all of that work in half, since there’re 26 biweekly payroll cycles per year. Or you can go to semimonthly payroll cycles, which is 24 times per year. So, the trick is to switch to a longer payroll cycle, so that you can process payroll fewer times – and preferably without pissing off any employees.

And a variation on this is when you have multiple payroll cycles in the same company, such as a weekly cycle for the hourly employees and a monthly cycle for the salaried staff. Bad idea, since that’s more cycles than you need. Instead, put everyone on one payroll cycle, and then, if you can, lengthen the cycle.

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Refinancing Debt (#125)

In this podcast episode, we discuss the pros and cons of debt refinancing. Key points made are:

Is it Possible to Refinance at All?

There are a surprising number of issues to consider, and they’re not all about saving money. First, there may be a technical issue. If you’re with a large company and you’ve issued bonds to investors, then refinancing debt really depends on whether the bonds are callable, and when they’re callable. If there’s no call date in the immediate future, then you’re out of luck on the refinancing.

The Lending Relationship

The next issue, and a much bigger one, is the lending relationship. I talked a lot more about this in the last episode. You need to weigh the possibility of getting lower-cost debt elsewhere against losing the relationship with your existing lender. This has a couple of ramifications. First, if you depart for greener pastures, how do you know that the new lender will be willing to work with you as well as the old one did? Of course, that’s assuming the old lender did help you out. If the old relationship was horrific, then I’d be willing to switch to more expensive debt with someone else just to get out the relationship.

But let’s assume that the old lender was pretty good. If your company falls on hard times, the existing lender has a lot of history with you, and might be willing to be more accommodating on debt repayment, or loosening up covenants. A new lender doesn’t have that kind of history with you, and there certainly hasn’t been a chance to build up any loyalty, so you might find yourself in trouble with a new lender who’s pretty rigid in its lending practices.

The Transfer of Banking Activity

A second problem with switching lenders is if it’s a bank doing the lending, and the bank wants you to switch over all of your banking activity to them. Now if you’re a treasurer and you’re the one who has to switch over all of the bank accounts, and ACH debits, and check stock, and lock boxes, and so on, you might consider suicide before making the switch. It’s a lot of work. And that’s a serious consideration.

The Interest Rate Swap

So here’s another issue. Do you want to refinance debt, not because of the interest rate, but because it’s a variable interest rate and you want a fixed rate? Or, in a few rare cases, the other way around? If so, it might be possible to do an interest rate swap. These are usually limited to larger companies, but it may be possible. So, for example, if you have a variable rate and you want a fixed one, you can offload the risk of interest rate changes to somebody else, and keep the debt you have.

The Need for More Equity

Here’s another thought. Over time, the risk position of a company changes. Maybe when you first lined up a loan arrangement, the company had a lot of equity and some cash reserves. What if that’s no longer the case? If you try to refinance your debt, any lender will look at your financial position right now, not the way it was a year or two ago. Bottom line, you may find that changes in your balance sheet will force you to bring in more equity in order to qualify for lower-cost debt. Does the ownership of the company want to do that? Maybe not. If not, you won’t be allowed to refinance debt, even if it otherwise seems like a good idea.

When to Load Up on Debt

Now, let’s flip that concept around. What if the company’s position has really improved since you lined up the existing debt package? In that case, absolutely try to refinance. And especially if lenders seem eager to lend. The credit markets have been horribly tight lately, but that can change – and over time, it probably will.

If you have that perfect convergence of great looking financials and an easy credit market, then refinance right away. It’s kind of like the parliamentary system – you call an election when you think you’ll have the best chance of winning it. The same thing goes with refinancing. You do it when you think you can get the best deal.  Not when the old debt agreement is about to expire.

Parting Thoughts

In fact, I’d say the mark of a really great treasurer is someone who keeps a close eye on financial statements and the credit markets, and pretty much always refinances early, when the timing is just right. And not only that, but when the timing is just right, go for as much debt as you can take, and for the longest possible period of time, and with very few covenants that are easy to meet. Those conditions don’t come along every day, so if you can use the cash – take it. And keep it for as long as possible.

So you can see that there’re a lot of issues. First in priority for most companies is maintaining a long-term, trusting relationship with a good lender. If the interest rate they offer is a little high, I might try to work them down on the rate, but I wouldn’t be overly inclined to switch to a new lender if I could help it. Maybe this is old school, but I think the relationship comes first, and saving a small amount on interest expense comes second. Maybe a long way second.

But. If the conditions are right – which means great financials and easy credit - and you can make a killing on a great refinancing, then strike hard and go for four things: a low interest rate, a lot of debt, a long debt term, and really easy covenants. It’s absolutely preferable to do this with your existing lender, but if someone else offers a killer deal, you’ve just got to take it.

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Lender Relations (#124)

In this podcast episode, we discuss the best way to handle a long-term relationship with a lender. Key points made are noted below.

Set Expectations

The first point with lenders is setting the proper expectations, and that starts with the initial meeting when you’re trying to set up a relationship. When you first describe your company to a lender, try not to be too optimistic about the company’s prospects. The problem is, that if you convince the lender that you’re going to take over the market and be bigger than IBM within three years, then that’s what they’ll expect you to do. And that means that every time you send them a financial report, it’ll be below their expectations, no matter how good the performance actually was.

This is not a minor point. I’ve worked for a couple of CEOs who gave some overwhelmingly optimistic presentations, and then I had to spend time talking these excited lenders down to a more realistic set of expectations. This doesn’t mean that you’re always cleaning up after the CEO. It’s worth your time to explain matters to the CEO in advance, and try to get him to understand that setting reasonable expectations is better for the long-term relationship.

Now, a part of those initial meetings with lenders will be a discussion of the company’s business plan, or budget. The same problem arises here. If you hand over a budget that shows a massive increase in sales and profits, then not only does the lender get very excited, but he’s also going to assume that your borrowing needs are going to be astronomical, since fast growth implies the need for a lot of cash.

So – first point - be prudent in setting expectations.

Limit Lender Covenants

My next point about lender relations is to fight back on loan covenants. This is the part of the loan agreement that says the lender can call the loan if certain things happen, like falling below a certain current ratio. If the lender sets the loan covenants anywhere near where your metrics currently are, then there’s a really good chance that you’ll blow through a covenant, and then you’ll have either an unhappy lender or a lender who wants to revise the terms of the loan. If you can’t avoid the covenants entirely, then this is a good time to negotiate the most liberal covenants you can get, so you have some breathing room on the numbers.

Limit Lender Reporting

And another thing you want to set is the minimum possible amount of financial reporting to the lender. The intent here is not to keep financial information away from the lender. Instead, the point is that the average business is going to have a bad month every now and then, and that’s just the way it is. But if you send out quarterly financials, the chances are pretty good that the bad months and good months will have evened out during the quarter, so you have better odds of reporting three months-worth of decent results. And that means no surprises for the lender.

Communicate Regularly

So, once the relationship is in place, what can you do to maintain relations? Well, a key issue is constant communications, which can come in a lot of forms. For example, if you send over the quarterly financial statements, it helps to do a follow-up call to ask if you can clarify the information. Or, do a scheduled quarterly or semi-annual lunch to discuss the business in general. Or, call every now and then to inquire about purchasing some additional services.

So, to clarify what I’ve said so far, lender relations is kind of like a speech. You use a conservative forecast to tell the lender how the company is going to perform, and then you report back that you did just what you said you were going to do. If you can do that consistently, lender relations will be good.

How to Deal With Poor Results

So what about when things go wrong? Well, you still have to look at the relationship as a long-term relationship, and that means you have to talk to the lender about the problems you’re having, and as soon as possible. The worst thing you can do is use some accounting trickery to push the problems out into the future, because all that means is that the problem will be even bigger by the time you finally tell the lender about it.

And their reaction will be, why did you wait so long to tell me, you miserable bum? And also, if you dump a really big crisis on them at the last minute, how likely are they going to be to work with you to resolve the problem?

So you do the reverse, and keep them informed up front. If you take that approach, you’re keeping the level of trust as high as possible, and you’re also giving the lender some time to see if there needs to be a workaround for your debt.

Now you may say that the lender has to work with you in a crisis, because what other choice do they have if they want to see their money again? Sure, that’s true – but you have to think long-term – after you get through that crisis, the lender is going to drop the relationship for certain, because you didn’t keep them informed.

Centralize Banking Activity

On to another topic. Let’s assume that the lender is a bank. The bank will want you to shift all of your banking business over to it as soon as it extends you a loan, so that it can earn fees on all of your other banking activity. And that’s an accepted part of doing business with lenders.

If you have a lot of banking activity, you might want to consider bending over backwards to shift even more banking activity over to the lender than they expect. When you do that, the amount of fees that the lender makes from the entire relationship starts to look pretty nice. And that helps when you want better loan terms. So if you make the relationship more valuable for the lender, it might be more willing to work with you over the long term.

Avoid Playing Off Vendors

And while I’m on the topic of fees, do not try to play lenders off against each other to get the absolute best possible price, and then keep doing it over time. If you have that kind of track record, lenders won’t be interested in a long-term relationship, and they’ll back out on you just when you need them the most. Instead, give them a fair profit.

Parting Thoughts

So in summary, the best lender relationship is based on not overly optimistic expectations, lots of communications, and giving the lender a fair amount of fees. Or, to flip that around, the worst relationship is based on absurdly high projections, no meetings, and pounding on the lender to cut fees down to the last penny.

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The Controller Position (#123)

In this podcast episode, we discuss many aspects of the controller position. Key points made are noted below.

The Controller’s Job

The job description appears fairly simple. The controller is responsible for all accounting transactions and related systems, and running the department, and issuing financial statements. That’s it. You’ll be shaking your head and saying “no, there’s so much more than that” but actually, yes – those are the core functions.

And that’s a hell of a lot. A good controller absolutely needs a four year degree in accounting, and a lot of experience. In short, when you sign up for accounting classes in college, this is the job that they’re preparing you for. It requires a lot of very specialized knowledge, and a really good controller is a very valuable person.

All right, no surprises yet – you could read that on any controller job description in the Internet. But then when you start digging in a bit more, you’ll find that there’re a lot of different types of controllers - and which type you are is driven by things like the size of the company, the type of industry, and whether there’s an emphasis on a particular skill.

How the Job Varies by Department Size

First, let’s talk about size. An awful lot of accountants are hired into a “controller” position and find that they’re the only one in the department, or maybe there’s a clerk or two. Surprise! You’re in a bookkeeper position, and that’s because you’re doing everything. So if you’re spending most of your time on data entry, this is you, even if they gave you a CFO title. Very likely the systems you run are simple, the accounting software cost a couple of hundred dollars, and you have no chance of advancement, because the company has no other positions for your skill set.

I would not be surprised if half the controller positions in the world are in this category. This does not necessarily mean that this type of controller position is one to avoid. Many people enjoy this type of work, and they’re happy. A real controller is spending most of the time managing, or reviewing information that been assembled by someone else, or reviewing systems.

If you think that’s you – you’re a controller. The key factor is that it’s a position in which you use all of that knowledge you’ve picked up in college to make sure that the accounting is done right – and if you’re doing data entry, you don’t have time to check your accounting theory. This describes maybe a quarter of all controller positions.

The Combined Controller/CFO Position

And then we have the combination controller and CFO. This is where you’re doing risk management and meeting with the bank, and fund raising, and doing investor relations – on top of all your other controller activities. In this case, the company probably can’t afford or doesn’t need both positions, so you’re combining the work load. This is a good position to be in, because you’re getting lots of practice for a real CFO job later on. And this is at most a quarter of the controller jobs.

The Public vs. Private Controller

Now, we have more variations on the position. A major one is if you’re the controller of a public company, instead of a private one. If that’s the case, you probably know a hell of a lot more about public company filing requirements than you ever wanted to know, and it’s possible that you’ve even regressed into doing nothing but financial reporting – in which case you’re in danger of sliding into a financial reporting position. Functionally, you’re not a controller any more. But if you can integrate that public reporting skill set into all of your other controller activities, it’s an amazingly valuable skill to have. Though you may not like doing this kind of work – very few people do.

The Industry Specialist Controller

But we’re not done yet. There’s also the controller who’s an industry specialist. There’s some very particular accounting associated with some industries, like construction, and oil & gas, and health care. In these cases, management usually doesn’t even consider hiring in a controller who has no experience in the industry – it’s just too risky that the new hire might not know something important, and screw up the accounting.

This means that some controllers have figured out early on that a specific industry skill set is very valuable, because it gives them a huge edge in getting hired within the industry. So if you’re an auditor and want to become a controller, start specializing in a specific industry. And the same goes for anyone trying to work their way up from within a company – pick a business in an industry with the most convoluted accounting rules imaginable.

The Functional Specialist Controller

And then we have the functionally specialized controller. You may very well be one of these. For example, some companies do a lot of acquisitions. If so, the controller with the acquiring company may spend about 80% of the time on integrating the acquisitions.

And then we have the companies that compete based on cost – and that tends to produce controllers with an incredibly strong process orientation – because they’re trying to squeeze every last penny out of the accounting operations. In both this and the acquisition situation, I could make a strong case that the controller is more of a process engineer. Accounting rules play a very small part in their lives. All they think about is processes and controls.

In companies where you have several of these specializations, like acquisitions, and public company reporting, and process reviews – it’s possible that the CFO decides not to have any controller at all. Instead, there may be a whole bunch of assistant controllers, and each one is a specialist in one of those areas.

Parting Thoughts

So how do we summarize all of this? First, about half of all controller positions are really bookkeeper positions. The remaining positions are on a continuum of light controller up to one that’s really a hybrid with a CFO position. And on top of that, there’s a lot of specialization by industry, such as health care, as well as specialization by function – such as acquisitions.

So what all of this means is that it’s pretty hard to find a controller position that really fits the standard job description. Instead, there’re all kinds of niche areas in which you can specialize. As long as you’re aware of these differences, you can alter your skill set to make yourself perfect for a particular type of controller position that very few other people are qualified for.

Related Courses

New Controller Guidebook

Fixed Asset Disposals (#122)

In this podcast episode, we discuss several reasons for keeping older fixed assets around a bit longer. Key points made are noted below.

This episode is about disposing of fixed assets – not the accounting for the disposal, but the issues you should consider before you actually do dispose of an asset. Anyway, this discussion is only about really expensive fixed assets where it’s worth your time to analyze the issues, not something cheap like a desktop computer that you’re going to swap out every few years.

When to Retain an Asset

Now, my first point is about the process you go through to buy a fixed asset. There may be a capital budgeting procedure, where someone has to formally apply to buy an asset; and you do a discounted cash flow analysis or a throughput analysis to see if it’s worth buying. But did you ever do an analysis that also includes the cost of just keeping what you already have, rather than buying a new asset at all?

In a lot of situations, there’s pressure inside a company to replace assets – maybe because there’s a bit more demand than the existing equipment can handle, or because the equipment is getting old and cranky, and the maintenance department is sick and tired of repairing it. Or maybe because it’s exceeded the recommended life span of the manufacturer.

Well, when any of these factors come into play, and the equipment doesn’t cost that much, chances are that management will just say fine – throw out the old gear and bring in the new. But what about cases where the old machinery is really expensive – or maybe it’s a whole facility that you’re thinking about replacing.

If you have a situation like this, then you need to start thinking about conducting an analysis maybe every year – and it’s mainly about what’s the cost of keeping this old clunker running just one more year? And if you’re a little short on capacity with that old asset, what’s the cost of turning away some business or outsourcing some production? This is a worthwhile discussion, because the cost of prolonging what you already have is usually way less than the cost of buying all new gear.

And if you think the risk of an old machine failing is all that great, you might want to measure the failure rate to see if it’s really as bad as you think. In a lot of situations, an old machine is really just very well broken in, and it doesn’t fail very much. In fact, you may find that the break in period for a new machine makes it less reliable than the old machine, at least for a few months.

Why Not to Throw Out Replaced Equipment

Now let’s say you’ve gone ahead and ignored my advice and bought new equipment. Even now, do you really want to sell off that old machine? After all, it may have some utility left, and chances are, you won’t be able to sell it for much. In a case like this, you may want to keep some reserve capacity on hand, just in case the new equipment breaks down. And if the new equipment is more automated than the old equipment that it’s replacing, there’s a pretty good chance that all that extra complexity is going to cause a failure.

In particular, if you like to focus on throughput, it makes a lot of sense to keep some excess capacity lying around, especially if it’s upstream from your bottleneck operation. If you want to learn more about throughput, go back to my episodes 43 through 47.

And here’s another thought. You may have to incur more cost to eliminate an asset than you would if you keep it. In particular, what if there’s a fair amount of environmental remediation cost involved? In cases like this, it may be more economical just to delay incurring those extra expenses a bit longer by hanging on to the asset.

Who Questions Fixed Asset Acquisitions?

So there’s a few things to consider. Now, who should be doing all of this questioning? The CFO should. In fact, the CFO is probably the only one who can. You see, the problem with capital budgeting is that an asset purchase builds its own bureaucratic momentum after a while, where there’s a pile of paperwork that everyone reviews and signs off on – and it has a sponsor somewhere who’s pushing it along. And here you are, trying to slow down the process and make people really think about whether it makes sense to keep using what you have, rather than buying that really neat, high-speed whatchamacallit.  It takes a CFO with some clout to do this.

Of course, since the CFO needs to be involved and the CFO is busy with other things, this means that he or she can’t get involved very frequently – so you have to make those few times count.

Therefore, to be efficient, the budget analyst or cost accountant needs to spot those situations where an asset is going to be disposed of, and where there may be a good reason to keep it. They notify the CFO and supply a complete set of backup information, and then the CFO goes into battle.

So why am I spending time beating on this topic so much? The reason is that if you can avoid a really large capital expenditure even once every year or two, that could mean a savings of millions of dollars.

Parting Thoughts

And by the way, what I’m talking about here is not black and white, like you proceed with a project or you kill it. What might very well come out of the discussion is a decision to scale back on a purchase to something less expensive, while also keeping the existing machine. And this outcome can still save a pile of money.

And that last point is worth chewing on a bit. The outcome is that you keep an existing asset and also make a reduced capital expenditure. What this does is give you two assets capable to doing the same thing, which gives you greater total capacity, but which has the added benefit of still giving you some capacity even if one of the machines breaks down. And means you’re averting the risk of a production stoppage by keeping the old machine.

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Capital Budgeting

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